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Buying a new home is exciting, but the process can be confusing and filled with unfamiliar terms. Along the way, you will likely hear about your debt-to-income ratio (DTI) and how it can affect your qualification
Your DTI is the percentage of your monthly income devoted to paying debts. Mortgage lenders include this ratio to determine your ability to repay a loan.
A low DTI means you have a good balance between debt and income, so a lower percentage increases your chances of approval. Lenders consider a DTI of 36% as a good ratio — with no more than 28% of that going toward your mortgage. The lower your DTI, the more competitive your mortgage rates will be.
Follow these instructions to calculate your DTI ratio:
Your monthly debt payments | |
---|---|
Credit card payments | Car loan payments |
Mortgage payments | Other loan payments |
Your monthly income | |
In general, 43% is the maximum debt-to-income ratio that mortgage lenders accept. However, an ideal front-end ratio, or amount you spend on your mortgage, is 28% and 36% is ideal for a back-end ratio — what you spend on the rest of your bills.
When lenders issue any type of loan, there’s always a risk of the borrower defaulting, so your interest rate is essentially a premium for the lender’s assumed risk. If you have a high DTI, it means that a good portion of your earnings already goes towards debts, which could affect your ability to make mortgage payments. Before your application is approved, lenders evaluate your DTI to determine your ability to repay the loan.
There are two parts to calculating your DTI:
For example, say you make $4,000 a month and spend $400 on a monthly car payment, $400 on your credit card bill and $800 on rent. This gives you a front-end DTI of 20% and a back-end ratio of 40%.
There’s a good chance you would be approved for a qualified mortgage, but the rate you’ll get depends on your lender’s preference for a front- or back-end ratio. For example, your front-end ratio could fall under the 28% cutoff, but you might not get the best rate if your back-end ratio exceeds 36%.
A qualified mortgage is a type of home loan that’s designed to be fair to borrowers. Lenders issuing this type of loan must meet certain requirements to ensure that you can afford to repay the mortgage.
Some of these requirements include prohibiting certain risky loan features or excess points and fees. And most importantly, it ensures lenders don’t lend to you with a debt-to-income ratio below 43%. However, qualified mortgage requirements don’t apply if you’re eligible to purchase through Fannie Mae, Freddie Mac or the FHA.
If you’re having trouble getting approved for a mortgage or simply want a better rate, there are a few ways to improve your DTI:
Your DTI is the most important factor when determining your mortgage rate — but your credit score and other expenses matter, too. DTI calculations don’t include monthly obligations such as insurance and utility payments, or food and entertainment costs. A high DTI could mean struggling to cover your mortgage payments and monthly expenses. So wait until your have a lower DTI ratio to get a good rae and avoid taking out a loan you can’t afford.
Your debt-to-income ratio is an essential measure that lenders consider when you apply for a mortgage. Whether you’re currently home shopping or preparing for the future, use the DTI calculator to find out where you stand.
Once you’re ready to apply, shop around and compare home loans to find the best option for your situation.
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